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By Paula Aven Gladych

Small-business groups have joined the chorus of retirement professionals upset with President Barack Obama's proposed retirement cap.

Opposition to the plan emerged almost immediately. The proposed $3 million cap on retirement savings could force small businesses to stop offering workplace retirement plans, the American Society of Pension Professionals & Actuaries said shortly after the president's plan was unveiled earlier this month.

The criticism hasn't stopped.

“Obviously it won’t hurt every small business, but there are a significant number it will hurt,” said Judy Miller, director of retirement policy at ASPPA.

In his budget blueprint, President Obama proposed a $3.4 million cap on how much money individuals can put into retirement accounts. The move would raise about $9 billion for the federal government over the next 10 years. The cap would prohibit taxpayers from taking advantage of the pre-tax deferral into their 401(k) or defined contribution pension plans after they cross that $3 million threshold, which is enough to fund a $205,000 annual annuity for a person wanting to retire at age 62.

According to data from the Employee Benefit Research Institute, a very small percentage of IRA and 401(k) investors would be affected by the cap. In 2011, only 0.06 percent of total IRA account holders had $3 million and only 0.0041 percent of 401(k) accounts had that much money in them at the end of 2012.

Still, the proposal is alarming on two levels, Miller said.
Small-business owners can’t rely on so-called non-qualified deferred compensation like big companies can, so their options are limited, she said. A company-sponsored retirement plan is a small-business owner’s only way to generate tax-deferred savings, unlike executives at large companies, who can “get pretty much anything, no limit,” Miller said.

Non-qualified deferred compensation is money that workers earn in one year but that is paid out in a future year, helping to lower tax liabilities.

It makes for a very uneven playing field, Miller said. “We really count on the nondiscrimination rules related to contributions to employer-based plans,” Miller said, adding:

"You take away the incentive they previously had to make contributions to other people and you’re going to end up with a lot of people, who are not intended to be the target, losing out under this proposal.”

Paula Calimafde, chair of the Small Business Council of America, doesn't go quite as far but is critical of other components of the proposal.

She doesn’t think that the $3 million cap will hurt the system because, mostly, such a small percentage of individuals would be affected by the cap.

The proposed cap would be preferable to proposals that came out during the fiscal cliff talks at the end of last year that would limit contributions going into a plan to the lesser of 20 percent of earnings or $20,000 per year.

That scenario would “trigger plan terminations or plans being frozen in the small-business sector because with the small-business sector, what makes the retirement plan system work is tax incentives,” she said. “If they are not strong enough to carry the weight of the internal administrative burdens and the cost of running a plan, including the cost of contributions for non-highly compensated employees, the owners will walk away from it.”

She added small business owners are more willing to sponsor a retirement plan and give employee matches or offer profit sharing if they have incentives to do so.

Calimafde pointed out that changes made to the tax incentives in the 1980s forced many small business owners to close or freeze their workplace retirement plans.
Ed Ferrigno, vice president of Washington Affairs for the Plan Sponsor Council of America, pointed out the $3 million cap also would apply to defined benefit plans.

“It complicates the hell out of things, particularly on the defined benefit side," he said.

Specifically, it would make it harder for small businesses to know which of their employees had maxed out their benefits and might be ineligible to set aside additional tax-deferred contributions. Many people have investment accounts outside of their workplace-sponsored retirement plan.

Both Calimafde and Ferrigno believe another “sleeper” provision in Obama’s proposed budget could have even more far-reaching consequences than the cap.

The proposed elimination of the "stretch" IRA -- which allows the amount remaining in an IRA at an employee’s death to be distributed over the life expectancy of the beneficiaries who inherit it -- would deter employees from fully using IRAs as a means of saving money.

As part of the president's proposed budget, individuals who save money in an IRA would have a harder time passing that money on to their children or grandchildren because the rules would force these secondary beneficiaries to take all of the money from that plan within five years of the account holder’s death.

The money would be taxed at a much higher rate if the beneficiaries are forced to take a large sum of money out of an IRA immediately, Calimafde said.

“It is important to many individuals who have accumulated funds that they can name their children as beneficiaries. This is why, for most employees, IRAs are a preferable alternative to annuities,” the Small Business Council of America said in comments this month to the House Ways and Means' Working Groups on Pension/Retirement and Small Business.

“With the ‘stretch IRA’ employees can invest in an IRA not only to secure their own retirement future but knowing that any remaining funds can provide their children with a safety net by allowing them to take the funds out of the IRA over their lifetimes rather than being forced to take the funds out in a lump sum as called for in this proposal,” according to the SBCA.
If this provision becomes law, many individuals will only save what they believe they will need in retirement in an IRA and put the rest in more tax-advantaged vehicles, the SBCA stated.

Another proposal that was put forth as part of the so-called fiscal cliff budget discussions was a 28 percent cap on the tax benefit for itemized deductions and exclusions.

According to Brian Graff, CEO and executive director of ASPPA, that proposal means a small business owner with a marginal tax rate of over 28 percent will pay a surcharge on elective deferrals to a 401(k) plan the year the contributions are made, and then pay tax again on the full amountwhen the contributions are paid out at retirement, amove that amounts to double taxation.

All three proposals would amount to a “new type of class warfare,” said Ferrigno.

“If you contribute at a high rate and you are successful in your investments, or worse yet, you have a defined benefit plan and a defined contribution plan, all of a sudden the rules have changed. For management of larger companies, it makes non-qualified investments more attractive. (But) you don’t want key decision-makers to have a disconnect from the benefits of rank and file workers.”

The bottom line is that most people won’t save for retirement without an employer-sponsored retirement plan, Ferrigno said. Low- and middle-income workers would be most hurt by these changes to retirement policy, he said.

“Instead of worrying about someone in a high bracket who is going to benefit (from these incentives), worry about those who could lose out if they are in the lower bracket if you change this policy,” he said.